Investment Analysis

Overview
Investment Objectives
 Investment process must start with a
clear objective/need
 Current Income (Safety)
 Capital Preservation (Moderate Growth)
 Capital Appreciation (Long Term Growth)
 Time Frame
 Short term
 Long term
 Intermediate
 Investment Objectives
 What do we like?
 Return!
 Total Return = Capital Gain + Reinvestment Income
Which is:
 Total return = capital gain (price appreciation)

+ reinvestment income (dividends or interest)

What do we fear?
 Risk!
 Risk of what? LOSS of principal
 Measuring Return
 Expected Return =
E(r) = (1+rf)(1+RP) – 1

 rf: nominal risk-free interest rate, includes

expected inflation (Current .1-2%, Estimate 2%)
 RP = risk premium (Historical 8%, Estimate 8%)
 Measuring Risk

E(r)
stocks

bonds
RP
rf T-bills

Risk
Investment Objectives
 Constraints:
 Liquidity needs
 Time Horizon

 Tax Factors

 Legal/Regulatory Factors

 Unique needs and preferences

Constraints Examples
 Liquidity needs - need money in near future, eg. for house,
education, redemptions, operations, etc …

 Time horizon - years to retirement, investment horizon mandate

 Tax factors - capital gains tax is paid when sell, dividends

and interest are taxed annually.

 Legal/regulatory factors - eg. no insider trading

 Other, ie. Socially responsible investing, ie. Not in cigarettes,

weapons, gambling, alcohol….
Implementing an Investment
Policy: 4 step process
 Devise a policy statement
 Study current financial/economic
conditions
 Construct the portfolio
 Monitor/update investor’s needs and
market conditions
 Process = DISCIPLINE
 The process is the same whether you are managing your own portfolio
or managing an institutional portfolio.

It represents the investment approach and is used to demonstrates

repeatable skill to investors.

Institutional investors include:

 Pension funds
 Insurance Companies
 Endowments
 Banks
 Investment banks
 Mutual funds
 ETFs
Implementing an Investment
Policy - Step 1
 Develop a Policy Statement
 Ascertain
 Objectives
 Risk Tolerance: determines our investment
policy
 Return expectations
 Implementing an Investment
Policy - Step 1 continued
A. Objectives:
 Current income
 Capital preservation
 Capital appreciation

B. Risk tolerance:
 Low tolerance: ST money market, high quality fixed income, blue
chip stocks, value stocks
 High tolerance: LT, growth stocks, more speculative

C. Return expectations (after-tax returns net of

expenses!)

Make sure risk tolerance and return expectations match

and that both match objectives
Implementing an Investment
Policy - Step 2
 Study economic and financial
conditions
 What is the Fed doing?
 What is happening in the real sector?

 What is happening politically?

Implementing an Investment
Policy - Step 3
 Asset allocation - several ways to
divide investment funds
 By markets:
 Real Assets vs. Financial Assets
 Capital Market vs. Money Market
 Debt vs. Equity
 Primary vs. Secondary
 Domestic vs. International
Implementing an Investment
Policy - Step 3 continued
 Asset allocation/security selection:
 Cash
 Bonds
 Stock
 International
 More diversification
 Exchange rate and country risk
 Scary stuff – Options, Triple Beta ETFs

SO,
 First: choose proportions among the 4
categories
 Then: choose securities within each category
Implementing an Investment
Policy - Step 4
 Manage!!!
 Kinds of management
 Active management
- try to beat the market
 Passive management

- develop a portfolio that

tracks the market
Summary of Investment
Process
 Determine investment objectives
 Study economic and financial
conditions
 Build a portfolio
 Manage
Where else will Investment
Analysis take us?
 Markets and Trading
 Risk and return for individual assets and
portfolios
 Why are these different animals?
 Fixed income valuation - quantitative
storytelling
 Equity valuation - storytelling
 Derivatives - why are they so risky?